Occasionally, situations arise where a family member, friend, or charity is in need of money and the question arises as to whether one can use an IRA to gift someone money. This article will explore the IRS rules for making a gift using retirement funds.
- It is possible to gift you IRA to an individual or a charity
- When gifting to an individual, he or she must not be a disqualified person and understand the cancellation of indebtedness rules
- Donating to a charity is straight-forward, the gift it not taxable, and would help satisfy minimum distribution requirements
What Transactions Can I do with an IRA?
Other than the usual investments you cannot make with an IRA, including life insurance and collectibles, the Internal Revenue Code (IRC) prohibits any transactions involving a disqualified person.
The definition of a “disqualified person” (IRC Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of such, and entities in which the IRA holder holds a controlling equity or management interest.
Thus, an IRA owner cannot engage in any transaction with a disqualified person, including via a gift. However, what about an IRA owner making a gift to a charity or non-disqualified person?
Gifting an IRA to an Individual
Can one lend IRA funds to a friend (or other disqualified person) and never receive payment back? Technically yes, but the borrower would have to take into account the amount of the cancellation of debt. Thus, the IRA loan that was not paid back would turn into income for the borrower under IRC Section 108 – cancellation of indebtedness rules.
Gifting an IRA to a Charity
Before we dive in, it’s important to note that IRS rules do not allow one to use an IRA to make a gift to a charity prior to the age of 70½.
Before 2023, the IRC allowed a taxpayer to exclude from gross income up to $100,000 per taxable year of certain distributions from IRAs made directly to charitable organizations. The exclusion is available only if the IRA owner is at least age 70½ at the time of the distribution, and any exclusion must otherwise qualify as a charitable deduction under the Code. Distributions to private operating foundations are acceptable, but not distributions to donor advised funds, supporting organizations or other private foundations
Beginning in 2023, as a result of SECURE Act 2.0, which is part of the $1.7 trillion-dollar omnibus spending bill signed into law by President Biden in December 2022, the $100,000 limitation will now be indexed for inflation. An IRA gift transfer, known as qualified charitable distributions (QCDs), offers eligible older Americans a great way to give to charity. This includes Roth IRAs, although it would not make much tax sense to make such distributions from a Roth. In addition, for those IRA owners who are at least 73, QCDs count toward the IRA owner’s required minimum distribution (RMD) for the year.
Since an IRA is tax-exempt, the amount sent to the charity as part of the QCD is not taxable, but also not tax deductible.
How Does it Work?
Any IRA owner who seeks to make a QCD for 2023 should contact his/her IRA custodian prior to December 31. It is suggested that one start the process a few months prior so that the custodian will have time to complete the transaction before the end of the year.
Typically, a distribution from a pretax IRA is taxable when received. With a QCD, however, these distributions become tax-free, as long as they’re paid directly from the IRA to an eligible charitable organization. QCDs can be made electronically, directly to the charity, or by check payable to the charity. It is important to remember that an IRA distribution, such as a wire transfer, made directly to the IRA owner, does not count as a QCD. Likewise, a check made payable to the IRA owner is not a QCD. It’s imperative that the IRA funds go directly from the IRA custodian to the charity.
Each year, an IRA owner, age 70½ or over, can exclude from gross income up to $100,000 of these QCDs. For IRA owners over the age of 73, the QCD can satisfy the RMD amount for that year up to $100,000 indexed for inflation. For a married couple, if both spouses are age 70½ or over and both have IRAs, each spouse can exclude up to $100,000 for a total of up to $200,000 per year. Moreover, the QCD opportunity is available regardless of whether or not an eligible IRA owner itemizes deductions on their income tax return. The amount of IRA funds transferred to the qualified charity is not taxable, although, no deduction is available for the transfer since an IRA is tax-exempt.
IRA Gift to a Split Interest Entity
A split-interest agreement is created when a donor contributes assets directly to a nonprofit organization or places them in a trust for the benefit of the nonprofit organization, but for which the organization is not the sole beneficiary.
New for 2023, SECURE Act 2.0 now allows for a QCD to allow for a one-time distribution from an IRA to a “split-interest entity,” such as a charitable gift annuity (CGA) or a charitable remainder trust (CRT). The total amount may not exceed $50,000. This exemption appears to be a one-time deal. In other words, you cannot make multiple payments over a number of years to get to $50,000. Based on the language in the Act, a split-interest entity means a charitable remainder annuity trust, a charitable remainder unitrust, and a charitable gift annuity, provided that the receiving entity is funded exclusively by qualified charitable distributions.
In the case of a charitable gift annuity, a contract is created between a donor and a charity with the following terms: The donor makes a gift to charity using cash, securities or possibly other assets. In return, the donor becomes eligible to take a partial tax deduction for the donation, plus receive a fixed stream of income from the charity for the rest of his or her life.
In the case of an IRA, the benefit of using IRA funds to fund a CGA is somewhat limited.
For example, if an IRA owner makes a one-time distribution of $50,000 to a CGA from a traditional IRA and at death is liquidated and reinvested and pays out $90,000 over the individual beneficiary’s lifetime, the first $50,000 of distributions would be subject to ordinary income from the IRA. Hence, using an IRA to fund a CGA does not offer much tax benefit; the IRA owner would likely be better off just making a distribution directly to a charity if their ultimate goal is to benefit the charity.
For those under the age of 70½, using IRA funds to gift to a charity is not possible. However, after that age, up to $100,000, now indexed for inflation, can be distributed to a charity tax free. Additionally, for those over the age of 73, the amount of the QCD can be used to offset the amount of any RMD owed. The new one-time $50,000 distribution rule for a split interest entity will likely have limited impact on most IRA owners.
And while it’s technically possible to gift an IRA to an individual, he or she must not be a disqualified person, and would be subject to the cancellation of indebtedness rules. Under certain circumstances, this may be an option for some people.